ProfessorBainbridge.com

"What Happens When the CEO or the Face of the Business Is a Risk? #MeToo and Corporate Governance"

Interesting post by Marcia Narine Weldon

Populism and Citizens United

I'm working on a project about corporate purpose and populism. I originally planned for it to include a section on Citizens United, but have decided that section needs to go. But having a place to publish work that has no where else to go has long been one of my main reasons for having a blog.

In my view, the case for Delaware’s rule of shareholder wealth maximization becomes even stronger when right-wing populists have significant political power. The populist contribution is not providing new theoretical constructs in the intellectual debate, but rather opening new political possibilities. As we shall see, one of the principle arguments in favor of Delaware’s rule is that the acknowledged externalities of corporate behavior are best addressed through general welfare legislation rather than via the fiduciary obligations of corporate directors.[1] Delaware Chief Justice Leo Strine and his coauthor Nicholas Walter contend that the U.S. Supreme Court’s Citizens United decision undermined that argument by changing the political dynamics in ways that strengthened corporate power.[2] Even if one accepts their argument,[3] however, a resurgent right-wing populism may provide alternative constraints on corporate political power sufficient to revitalize the argument for leaving regulation of corporate externalities to general welfare legislation.

A standard move in the corporate social responsibility debate by defenders of the shareholder wealth maximization norm is the claim that the legislative and “regulatory process [is] an adequate safeguard against corporate overreaching for non-stockholder constituencies and society generally.”[4] Various commentators, notably including Delaware Supreme Court Chief Justice Leo Strine, contend that a wave of corporate political spending unleashed by the controversial Citizens Uniteddecision[5]undermines that argument:

Because corporate wealth far exceeds that held directly by human beings, if corporations are able to act directly to influence who is elected to office, the laws and regulations in our society will increasingly tend to tolerate the imposition of greater externalities, because they will be enacted by politicians who have been elected in an expensive process in which money matters, and in which securing the support of non-human corporate money with a monocular focus on profit will be important to electoral competitiveness.[6]

I have elsewhere disagreed with their argument on several grounds. First, “much corporate political spending is likely to be defensive,”[7]being aimed at staving off additional regulation rather than eroding existing regulations.[8] Absent “a showing that the benefits of foregone regulations exceed their costs, there is no reason to assume that corporate political spending increases the extent to which corporations can externalize costs.”[9]

In addition, Strine and Walter fail to explore the implications of the fact that large corporations dominate corporate campaign spending. First, spending by such corporations is highly constrained by reputational considerations due to “the seriousness with which large corporations treat any potential threats to their goodwill arising from ... negative publicity” generated by unpopular contributions. Second, and more important, while Strine and Walter assume corporations use political spending exclusively to externalize the negative costs of their activities, the reality is that large corporations frequently support regulations that force corporations to internalize social costs. They do so because such regulation can create significant costs for smaller competitors and barriers to entry for startups. Because regulatory costs frequently do not scale, they are often borne disproportionately by small businesses and startups. This observation is not offered as a defense of corporate political spending, but solely as a critique of Strine and Walter’s assumption that corporate political spending is inevitably anti-regulation.[10]

The rise of right-wing populism as a viable political force strengthens the case against Strine and Walker’s Citizens United argument. Although the early Tea Party activists tended towards libertarian views on economic issues and regulation,[11] the right of center populist movement is evolving towards an increasingly anti-business stance. This sentiment may well find expression in a regulatory agenda analogous to the Southern Agrarian program. If so, the risk that Citizens United will permit corporations to externalize more costs will be further mitigated.

Democracy is not an appropriate metaphor for corporate governance

There is an interesting new paper on shareholder proposals, about which I will have more to say in future posts. At the moment , however, this passage caught my eye:

Corporations are often compared to democracies (Gompers, Ishii, and Metrick, 2003), in which the ultimate authority rests with voters (shareholders). An advantage of well-working democracies is that virtually anyone can make proposals to change policies.

Gantchev, Nickolay and Giannetti, Mariassunta, The Costs and Benefits of Shareholder Democracy (March 1, 2019). SMU Cox School of Business Research Paper No. 18-35; Swedish House of Finance Research Paper No. 18-15; European Corporate Governance Institute (ECGI) - Finance Working Paper No. 586/2018. Available at SSRN: https://ssrn.com/abstract=3269378 or http://dx.doi.org/10.2139/ssrn.3269378

To which I would respond:

Just as a large city cannot be run as a New England town meeting, a large corporation is a poor candidate for direct democracy. There simply are too many widely dispersed shareholders who have varying degrees of information about the company, differing goals and investment time horizons, and competing ideas about optimal business practices for their preferences to be aggregated efficiently. Accordingly, state corporate law traditionally has given primary decision-making authority to the board and the managers to whom the board properly delegates authority. As the Delaware General Corporation Law puts it, the “business and affairs” of a corporation “shall be managed by or under the direction of a board of directors.”

Stephen M. Bainbridge, Revitalizing SEC Rule 14a-8's Ordinary Business Exclusion: Preventing Shareholder Micromanagement by Proposal, 85 Fordham L. Rev. 705, 707–08 (2016).

Recommended Reading on "Rogue Corporations"

I really liked this article by Justin Pace:

On February 28, 2018, Dick’s Sporting Goods announced that it would no longer sell long guns to 18- to 20-year-olds. On March 8, 2018, Dick’s was sued for violating the Michigan Elliott-Larsen Civil Rights Act, which prohibits discrimination on the basis of age in public accommodations. Dick’s and Walmart were also sued for violating Oregon’s ban on age discrimination. In addition to corporate liability under various state civil rights acts, directors of Dick’s and Walmart face the threat of suit for breaching their fiduciary duties—suits that may be much harder to defend than the more usual breach of fiduciary duty suit.

Delaware corporation law appears to have an underappreciated per se doctrine where the board directs the corporation to violate the law. A knowing violation of positive law is bad faith, which falls under the duty of loyalty. The business judgment rule will not apply and exculpation will not be available under Section 102(b)(7). The shareholders may not even need to show harm.

This paper examines the relevant legal doctrine but also takes a step back to consider what the rule should be from an ethical and a moral standpoint. To do so, rather than apply traditional corporate governance arguments, this paper considers broader moral theories. In addition to the utilitarian calculus that is so ubiquitous in corporate governance scholarship via the law and economics movement, this paper considers the liberalism of both John Rawls and Robert Nozick. But liberalism may seem less persuasive given the rise of illiberalism politically on both the American right and left. Given that, this paper also considers two non-liberal models: one a populist modification of Charles Taylor’s democratic communitarianism and the other Catholic Social Thought.

Unsurprisingly, the proper rule depends on which moral theory is applied. If that theory is liberalism (of either form covered), then a per se approach is troubling. Harm to the corporation must be shown, and either the Delaware legislature or the corporate players, depending on the form of liberalism, must acquiesce to a per se rule. Counterintuitively, it is the per se rule that runs counter to basic democratic norms. It gives the power to litigate in response to harm not to the party harmed but to a third party. Given the divergent results from applying different moral theories, and given the democratic difficulty, the Delaware legislature should clarify the standard. It will likely find that a harsh, per se standard is unjustified.

Pace, H. Justin, Rogue Corporations: Unlawful Corporate Conduct and Fiduciary Duty (February 11, 2019). Available at SSRN: https://ssrn.com/abstract=3332667 or http://dx.doi.org/10.2139/ssrn.3332667

Are companies going to comply with the California board of director gender quota law or will some resist?

Based on the two companies to have filed pertinent proxy statements to date, it looks like passive acquiescence is the order of the day. Admittedly, this is not a large sample.

Saying goodbye to entire fairness

My friend and UCLAW colleague Iman Anabtawi recently wrote an insightful article on Delaware's evolving jurisprudence on conflict of interest transactions, especially in the M&A context:

Merger and Acquisition (M&A) transactions create the potential for self-interested behavior by the boards of directors of acquired, or target, corporations because target boards may have self-interested reasons for preferring one acquirer over any other. The preferred acquirer may, for example, be more likely to retain the services of certain board members or to employ them in some other capacity after the completion of the transaction. In recognition of these potential conflicts of interest, the courts have recognized that target boards of directors may not always be incentivized to exercise their business judgment in M&A transactions in the best interests of shareholders and have therefore held them to the heightened standard of review of enhanced scrutiny. Enhanced scrutiny contemplates substantive judicial review of the reasonableness of the target board’s conduct in the sale of the company. Until recently, enhanced scrutiny review was not susceptible to being adjusted downward to business judgment-level review through procedural safeguards, such as the constitution of a special committee of the board or shareholder ratification. A special committee was not considered to be an effective means of cleansing an inherent conflict, and shareholder approval of the transaction was deemed to approve only the board’s decision to sell, as opposed to the board’s conduct of the sale process. The Delaware Supreme Court revisited the issue, holding that the shareholder ratification doctrine applies to a shareholder approval of an M&A transaction on the rationale that shareholders, particularly institutions, are at least as well-positioned as judges to evaluate the merits of a sale. As a result, approval of an M&A deal by target shareholders displaces enhanced scrutiny of the board of directors’ conduct in managing the sale in favor of the business judgment rule, effectively making the target board’s decision unreviewable. This Article argues that recent Delaware jurisprudence on shareholder ratification constitutes a fundamental shift in M&A jurisprudence, predicts that, while it will reduce deal litigation, it will have unnecessary detrimental effects on deal process, and proposes a procedural mechanism for mitigating those effects in the form of a bifurcated shareholder vote on each of the deal process and the sale transaction.

Anabtawi, Iman, The Twilight of Enhanced Scrutiny in Delaware M&A Jurisprudence. 43 Delaware Journal of Corporate Law (January 2019, Forthcoming); UCLA School of Law, Law-Econ Research Paper No. 18-11. Available at SSRN: https://ssrn.com/abstract=3248474

Amir Licht has just posted an article that deserves to be read in conjunction with Iman's piece:

This Essay entertains the idea that Delaware’s corporate law is set on a trajectory that would eventually lead to reforming its doctrine of entire fairness as we now know it by retiring the doctrine’s substantive fairness review prong and insisting on fully-informed consent as the only way for validating tainted transactions. A growing array of cases, in which the centerpiece is Kahn v. M&F Worldwide Corp. (MFW), creates a legal sphere within which traditional entire fairness analysis has no application. Within this sphere, things rise or fall depending solely on the existence or absence of an uncoerced fully-informed ratification, in line with fundamental principles of fiduciary law in Delaware and in other common law jurisdictions. The critical move, which may take time to materialize, will take place when the courts deal the traditional doctrine the coup de grâce and abolish substantive fairness review entirely, if one may say so. Treating this development as highly desirable in principle, this Essay discusses practical and normative issues that call for attention in order to ensure its successful functionality, including the use of technology to ensure the integrity of informed consent through shareholder voting and the rise of institutional cross ownership, which may call for special attention in MFW-relevant settings.

Licht, Amir N., Farewell to Fairness: Towards Retiring Delaware's Entire Fairness Review (February 8, 2019). European Corporate Governance Institute (ECGI) - Law Working Paper No. 439/2019. Available at SSRN: https://ssrn.com/abstract=3331097 or http://dx.doi.org/10.2139/ssrn.3331097

Yvan Allaire makes "The Case for Dual-Class of Shares"

Allaire, Yvan, The Case for Dual-Class of Shares (December 20, 2018). Available at SSRN: https://ssrn.com/abstract=3318447 or http://dx.doi.org/10.2139/ssrn.3318447

The debate over whether dual class of shares increases or decreases share value, should be prohibited or not, should be subjected to mandatory sunset provisions, and so on has been heating up over the last few years. This paper reviews the pros and cons of dual class of shares in light of more recent empirical results of (mostly) American studies. The paper surveys the evolution of dual-class companies in the Canadian context and makes a number of recommendations to enhance the usefulness of this type of capital structure and protect the rights of minority shareholders.

The paper comes out against time-based sunset clauses but supports the obligation for dual-class companies to adopt a “coattail” provision, as is the case in Canada, which provision ensures that all shareholders will have to be offered the same price and conditions should the controlling shareholder decide to sell its controlling stake in the company. The paper also recommends that separate tallies of vote results be made public for each class of shares and that a third of board members be elected by shareholders with “inferior” voting rights.

Not only is there growing evidence of their better economic performance but the coupling of dual class and family ownership brings about longer survivorship, better integration in the social fabric of host societies, less vulnerability to transient shareholders and more resistance to strategic and financial fashions.

This precious form of ownership must come with appropriate measure to ensure and protect the rights of minority shareholders.

I have addressed the issue in prior posts:

Understanding Dual Class Stock Part I: An Historical Perspective

Understanding Dual Class Stock II: The Flawed Corporate Democracy Argument

Understanding Dual Class Stock III: The Conflict of Interest Argument

Another state decides to take on Delaware. Reserve a space for Wyoming on Boot Hill.

In corporate law, Delaware is kind of like the movie gunslinger that "every piss-ant prairie punk who thought he could shoot a gun would ride into town to try out." And like that gunslinger, Delaware "must have killed more [states] than Cecil B. DeMille." (Bonus points for spotting the source of the quotations.) 

Most recently, North Dakota tried. I predicted that effort would fail. It did.

Bloomberg reports that now Wyoming's going to try:

Wyoming is looking to compete with Delaware as a corporate-friendly destination by creating a specialized court that offers lower fees and speedy dispute resolutions.

The proposals are part of a broader push by Wyoming lawmakers to make the state that invented the limited liability company (LLC) into a fintech friendly “Delaware of the West.”

Separate bills planned for the Wyoming state legislative session that started this week would use blockchain technology for commercial filings and business registrations and create a special purpose state-chartered depository bank intended to serve the blockchain industry.

Good luck with that.

A proponent of Wyoming's effort told Bloomberg that “when you go to other competing jurisdictions, a lot of times they have specialty courts that can deal with those specific issues.” It's true that the Delaware Chancery Court specializes in corporate law. But what that overlooks is that Delaware has a 100+ year head start. What matters is not having a specialized court, but having a huge volume of case law. What transactional lawyers (who advise their clients on where to incorporate) want is predictability and certainty. The vast volume of Delaware decisional law makes it possible, in most cases, to write an opinion letter with confidence. Wyoming's new court will be starting from scratch.

As for the much ballyhooed blockchain laws, Delaware's legislature is an expert at spotting new trends and incorporating them into its law. On the blockchain front, Delaware has already moved and doubtless will be evaluating what Wyoming does. If need be, Delaware will copy (and likely improve) the Wyoming laws. 

So I fully expect Wyoming to join North Dakota, Nevada, Pennsylvania, etc... who "finally found a home under the boot hill grave that bears [their] name."

Pileggi's Annual Review of Key Delaware Corporate and Commercial Decisions

Francis Pileggi's invaluable Annual Review of Key Delaware Corporate and Commercial Decisions for 2018 is online. It's a must read for anybody working in corporate law.

Speaking of "principal executive office" under California corporation law, what exactly does it mean?

In the preceding post, I noted the centrality of the term "principal executive office" to the application of California's corporate board gender quota bill. Keith Paul Bishop notes California corporate law fails to define this key term despite its appearance I numerous provisions of California corporate law.

Similarly, SEC Form 10-K and 10-Q require that the corporation disclose its principal executive office without defining that term. Having said that, Rule 3b-7 defines “executive officer” as the company’s “president, any vice president ... in charge of a principal business unit” or any other “officer” or “person” who “performs similar policy making functions.” Logically, "principal executive office" would mean the place where the CEO and most other executive officers work most of the time.

In federal tax law, "principal executive office" is "generally understood to mean 'the head office, the place where the principal officers generally transact business, and the place to which reports are made and from which orders emanate.'” Dimmitt & Owens Fin., Inc. v. Unique Industries, Inc., 589 F. Supp. 14, 16 (N.D. Ill. 1983), aff'd sub nom. Dimmitt & Owens Fin., Inc. v. U.S., 787 F.2d 1186 (7th Cir. 1986).

 

 

The ambiguous application of California's Corporate Board Gender Quota Law (SB 826)

Keith Paul Bishop has spotted two key ambiguities:

SB 826 (Jackson) is reputably the first state law requiring publicly held corporations to have a minimum number of female directors.  It is generally assumed that the law applies only to those publicly held domestic and foreign corporations having their principal executive offices in California.  But is that what the new law actually provides?

The bill adds two sections to the California Corporations Code.  The first, Section 301.3, expressly imposes a quota on "a publicly held domestic or foreign corporation whose principal executive offices, according to the corporation’s SEC 10-K form, are located in California".  This language is ambiguous as to domestic corporations.  Did the legislature intend to impose gender quotas on all publicly held domestic corporations or only those with principal executive offices in California?

The scope of law becomes even more muddied with respect to publicly held foreign corporations.  While Section 301.3 includes a requirement that the foreign corporation's principal executive offices be in California, SB 826 also added a new Section 2115.5 that provides:

"Section 301.3 shall apply to a foreign corporation that is a publicly held corporation to the exclusion of the law of the jurisdiction in which the foreign corporation is incorporated."

Noticeably absent from this section is any requirement that the foreign corporation's principal executive offices be in California. 

I hope Keith is right that "it is unlikely that the legislature believed that it could impose its will on foreign corporations with no connections to California." But then again the California legislature has done odder things than that. In any case, I definitely agree with Keith that the statute is probably unconstitutional even if we assume that the bill implicitly requires that the foreign corporation have its principal executive office in California.

Fisch and Solomon on Sunset Provisions in Dual Class Stock

An important and insightful new article on a hot topic:

An increasing percentage of corporations are going public with dual class stock in which the shares owned by the founders or other corporate insiders have greater voting rights than the shares sold to public investors. Some commentators have criticized the dual class structure as unfair to public investors by reducing the accountability of insiders; others have defended the value of dual class in encouraging innovation by providing founders with insulation from market pressure that enables them to pursue their idiosyncratic vision.

The debate over whether dual class structures increase or decrease corporate value is, to date, unresolved. Empirical studies have failed to provide conclusive evidence as to the effect of dual class structures, and calls for regulators or stock exchanges adopt prohibitions banning dual class structures outright have been unsuccessful, although several index providers have banned dual class stock from major indexes such as the S&P 500.

As a result, some commentators have advocated a compromise position permitting corporations to go public with dual class structures but requiring that they be required to include mandatory time-based sunset provisions. The sunset provisions would automatically convert the dual class structure to a single share structure after the passage of a pre-determined period of time. The Council of Institutional Investors has asked the New York Stock Exchange and Nasdaq to refuse to list the shares of dual class firms unless they contain a time-based sunset provision that would convert within seven years.

We do not take a position on whether dual class structures are value-enhancing, but we challenge the proposition that time-based sunsets are an appropriate response to the debate over dual class and that they should be imposed through regulation or stock exchange rules. To the extent that dual class structures are problematic, sunsets do not solve that problem. Moreover, time-based sunsets are an arbitrary response to the concern that developments such as the decline in a founder’s economic interest or the transfer of high-vote shares to third parties may reduce the attractiveness of the dual class structure. In addition, time-based sunsets create potential moral hazard problems. We further argue that the limitations of time-based sunsets cannot be addressed through a retention vote by the minority shareholders due to the problematic incentives of the minority shareholders.

We observe that event-based sunsets, which have received less attention, focus on the specific developments that are likely to erode the potential value of dual class, and we call for market participants to explore them further through private ordering. Nonetheless, we argue that, at the present time, investors and policymakers lack sufficient information about either dual class or sunsets to justify using regulation, index requirements or stock exchange rules to force companies into adopting sunsets. We further argue that, rather than relying compulsory sunsets to evade the difficult policy issues raised by dual class, the debate should encompass a more thorough framing of the role and importance of shareholder voting rights.

Fisch, Jill E. and Davidoff Solomon, Steven, The Problem of Sunsets (December 17, 2018). Boston University Law Review, 2019, Forthcoming; U of Penn, Inst for Law & Econ Research Paper No. 19-04. Available at SSRN: https://ssrn.com/abstract=3305319

Delaware forum selection clauses cannot apply to "rights or relationships" not created by Delaware law

Francis Pileggi throughly analyzes the important new Sciabacucchi v. Salzberg decision, in which "the Court determined that a forum-selection clause in a certificate of incorporation was invalid and ineffective to the extent that it purported to 'require any claim under the Securities Act of 1933 to be brought in federal court' (the 'Federal Forum Provisions')."

California appeals court enforces forum selection bylaw of Delaware corporation

Keith Paul Bishop:

Below are some notable observations from the opinion by Justice Franklin D. Elia:

• "[N]either California nor Delaware law requires forum selection clauses be freely negotiated to be enforceable."

• "The forum selection bylaw is entirely consistent with Drulias's reasonable expectations at the time he chose to purchase stock in 1st Century."

• "Forum selection bylaws have the effect of consolidating such litigation into a single forum, thereby reducing litigation expenses and avoiding duplication of effort (not to mention promoting efficient use of judicial resources), which is beneficial to corporations and their shareholders alike."

Samuel Moyn misunderstands the purpose of teaching corporate law

Michael Simkovic:

In a thought provoking essay in the Chronicle of Higher Education, Professor Samuel Moyn argues that law schools' focus on judge made law in general, and the Supreme Court in particular, is counterproductive especially when justified on ostensibly progressive grounds.  Offline, Professor Moyn suggested that, to better help students understand how the legal system influences the distribution of economic and political power, progressives should focus more on teaching business law subjects like taxation and anti-trust.

Samuel Moyn, Law Schools Are Bad for Democracy: They whitewash the grubby scramble for power, Chronicle of Higher Education, Dec. 16, 2018.

In re the highlighted portion, insert eye roll here. Personally, I thought the purpose of training students in business law was to make them more effective business lawyers by teaching them the skills transactional lawyers use in the real world, not to fill their heads with a bunch of progressive nonsense about the evils of capitalism.